Is Your Preferred Stock About To Be Called?

Includes: BAC, D, EQC, ONB, PSA, SR
by: Doug K. Le Du

Huge demand for high quality [1] preferred stocks has pushed up market prices. The sudden increase in demand has been caused by a large number of calls, all occurring within a very short period of time. So far this year we have seen seventeen high quality preferred stocks called by their issuing companies. That has to be a record pace [2].

These calls have pushed a large number of suddenly cash-rich preferred stock investors into the marketplace as buyers, all looking to replace their called shares at the same time, hence pushing up prices. With this increase in market prices, many preferred stock investors are currently sitting on significant, but unrealized, capital gains in their preferred stock portfolio, leading many to wonder if they should pocket those gains by selling now.

If the issuing company decides to call (redeem) your shares, the opportunity to cash in those gains evaporates instantly, as the market price will fall toward par (usually $25 per share) as soon as a call is announced. Several of the issues called this year were selling for prices well above their par values just before the call announcement, so many of those holding shares at the time would have dearly loved to have known that a call was heading their way.

This is especially true of high quality preferred stock shares that are so widely held. Most of the 40 callable high quality preferred stocks that are currently trading on U.S. stock exchanges closed on Friday, April 20 for a market price above their respective par values.

What Is The Likelihood Of A Call?

In most cases, a company will call a preferred stock if it saves them money to do so. For example, earlier this year Public Storage (NYSE:PSA), taking advantage of today's low rates, issued PSA-T, a new preferred stock with a 5.750% dividend rate. The proceeds generated by the new PSA-T were used to call PSA-M, issued in 2007, that was costing Public Storage 6.625% in annual dividend expense. Introducing a lower payer to call an older, higher payer produced an instant 0.875% savings to the company (6.625% minus 5.750%).

But what about a case where the savings was only, say, 0.500% or even as low as 0.250%? What amount of savings to the issuing company is compelling enough to trigger a call? Once we identify the amount of dividend expense savings that tends to trigger a call, you can use that knowledge to assess whether or not selling and collecting your capital gains now is a move that you should be considering.

To understand the likelihood of a call we have to take a look at how companies have made this decision in the past. How much dividend savings has it taken to trigger a call and how does that trigger point relate to today's preferred stock market?

The Trigger Point

High quality preferred stocks become callable five years after they are introduced to the marketplace. So, in order to determine the likelihood of a call, we need a study period where rates were lower five years after the date of issuance. The Global Credit Crisis of late-2007 through 2009 pushed dividend rates up much higher than they are today (all the way to 9.6%). With these crisis-era issues becoming callable between 2012 and 2014, the crisis period will provide a great study period (lots of calls as we are already starting to see), but we'll have to wait a couple more years for more of that data to materialize.

Preferred stocks issued during 2003 through 2006 do not work well for this analysis since dividend rates were lower during that period than they were five years hence (2008 through 2011) during the crisis.

But high quality preferred stocks issued during 2001 and 2002 are just what we are looking for. These preferred stocks became callable during 2006 and 2007, respectively. Dividend rates were lower during 2006 and most of 2007 than they were five years earlier, creating favorable conditions for calls. So by looking at preferred stocks issued during 2001 and 2002, we are able to assess how much savings to the issuing company was required to trigger a call.

Each bar on this chart is a high quality preferred stock issued during 2001. Of these 35 issues, 29 have been called while six are still trading. The vertical axis shows the savings that the issuing company realized (or could have realized in the six cases that are still trading) by issuing a new preferred stock and using the proceeds to call the more expensive 2001 issue.

Preferred Stocks Issued In 2001 That Were Called

Notice that where the savings were less than .375%, the results are mixed - about half of the issues were called while the other half were not. But once the savings of issuing a new preferred stock (and using the proceeds to call the more expensive 2001 issue) exceeded 0.375%, all but one preferred stock issued during 2001 was called.

For high quality preferred stocks issued during 2001, a savings of 0.375% was the "trigger point" beyond which issuing companies called their preferred stock shares. We see a very similar result when looking at the calls of the 22 high quality preferred stocks issued during 2002 [3].

Preferred Stocks Issued In 2002 That Were Called

In the eight cases where the savings was 0.300% or less, three of these 2002 issues were called while five were not. But when the dividend savings to the issuing company was greater than 0.300%, ten out of fourteen high quality preferred stocks issued during 2002 were called [4].

About To Be Called?

The implication here is that if you hold callable shares of a high quality preferred stock issued by a company that can issue a new preferred stock today at a dividend rate that is at least 0.300% lower than the shares you are holding, there is a significant risk of a call.

As always, some degree of care needs to be taken when applying historical results to today's circumstances. The Wall Street Reform Act, signed into law in July 2010, directly affects the call decisions related to trust preferred stocks (TRUPS). Please read my Seeking Alpha article titled "The Hidden Risk Of Buying Today's Trust Preferred Stocks."

So how do you determine the dividend rate at which the issuing company of one of your callable, high quality preferred stocks is able to introduce a new preferred stock issue today? Simple. All you need to do is look at the current yield that their preferred stocks are commanding in today's marketplace [5].

If you are sitting on an unrealized capital gain on a callable, high quality preferred stock where the issuing company could introduce a new preferred at a dividend rate that is at least 0.300% lower than the shares you hold, you may want to consider whether or not selling no--, and cashing in your gain-- is in your best interest.


[1] "High quality" preferred stocks are those that meet the ten risk-lowering selection criteria from chapter 7 of my book, Preferred Stock Investing. For example, high quality preferred stocks have investment grade ratings and the cumulative dividend requirement).

[2] Sources for all preferred stock data in this article: CDx3 Notification Service database,, Preferred Stock Investing, Fourth Edition, see Disclaimer: The CDx3 Notification Service is my preferred stock email alert and research newsletter service including data for all preferred stocks and Exchange Traded Debt Securities traded on U.S. stock exchanges.

[3] There were a total of 29 high quality preferred stocks issued during 2002, seven of which have been omitted from this analysis due to privatization (BGI-T, EOF-G); missing historical data (CWH- from CommonWealth REIT (NYSE:CWH), BAC-X from Bank of America (NYSE:BAC)); called in response to the Wall Street Reform Act (ONB-B from Old National Bancorp (NYSE:ONB)); or called after the issuing company had apparently purchased back the shares for less than par on the open market during the crisis (VEL-A from Dominion (NYSE:D), LG-A from Laclede Group (LG)).

[4] In all cases the 2001 and 2002 preferred stocks that have yet to be called are trust preferred stocks issued by publicly traded bank holding companies. In the absence of the 2010 Wall Street Reform Act, the 2001 and 2002 TRUPS that have yet to be called almost certainly would have been by now.

[5] Your broker's online system provides this value. Otherwise, all you need is to plug today's price quote into the following formula (the [$par] amount is usually $25 but check the prospectus to be sure):

Yield% = {([$par] x [your dividend%]) divided by [$today's price]} x 100

For example, if you own a callable preferred stock that pays you a 7.25% annual dividend and is currently selling for $26.50 per share, the yield would be 6.8%.

6.8% = { ([$25] x [7.25%]) divided by [$26.50] } x 100

In other words, the market is saying that they are willing to pay $25 (PAR) for a preferred stock that offers a 6.8% annual dividend from this fictional company. Introducing a new 6.8% issue would produce a dividend savings to the company of 0.450%, well beyond our 0.300% trigger point, meaning that this fictional preferred stock is probably a good candidate to be called.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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